Bitcoins, deflation and the slightly silly impact of loss

I think Bitcoins and the Blockchain are amazingly cool. I still don’t think Bitcoins are a useful currency and I worry that many of Bitcoin’s biggests fans also like the gold standard, Austrian economics and some other crazy stuff.

What impact will the loss of Bitcoins over time have on the economy?

Why Bitcoin as a national currency will damage the economy

One of my concerns with Bitcoin as a national or universal currency is actually something proponents claim as a benefit. There is a finite number of Bitcoins that will ever be available. At the moment, the increase in the supply of Bitcoins is a positive number. Even with that, due to hoarding of Bitcoins and a little bubble mania, the price of virtually everything measured in Bitcoins is experience hyper deflation. (If that sounds odd, spend a minute thinking about it. We are used to thinking of the price of Bitcoins in Sterling or USD or ZAR, rather than the price of eggs or houses in Bitcoins.)

Deflation

Deflation of prices measured in Bitcoins is virtually assured in the long term, provided the global economy continues to grow. More stuff being bought, more services provided, more people being paid, more assets existing being chased by a finite number of bitcoins will lead to deflation. Which in turn leads to hoarding, unavoidably high real interest rates and contractionary pressure on the economy. This is a slice of Japan over the last 30 years.

But… negative interest rates?

We have limited negative nominal interest rates in certain markets at the moment. To be fair, this was unexpected when it happened some years ago, but is now relatively normal. Not all of the reasons for negative interest rates in Euro denominated sovereign bonds will apply to Bitcoin though, so I don’t believe that will be an out from high (positive!) real interest rates.

Alternative view, Bitcoins are infinitely substitutable

The aside I traditionally make at this point is that Bitcoin can have infinitely many substitutes. So the risk may be one of deflation, but could also be of eventual progression to nil value due to substitutes.

What to do about lost Bitcoins?

Now onto the point of this post. Bitcoins get “lost” all the time. You lose your wallet encryption key and the Bitcoins are gone forever. With fiat currency, the total money supply can be managed so that if somehow a fire burnt up a meaningful part of the money supply, more money could be created. It would still be a loss for those who lost the money, but at least the economy wouldn’t have to stumble along with a decreased money supply indefinitely.

If Bitcoins are lost at a positive probability per year, this will decrease the supply, adding to the deflationary problems described above. Yes, this is mostly an academic point because the targeted real rate of economy growth is likely way higher than the rate of loss of Bitcoins, so the contribution to the overall problem is small.

My suggestion? Do the world economy some good and give me your encryption keys for safe keeping. Just in case.